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Key Points in Understanding the Oil Crisis
The price of a barrel of US crude oil in the West Texas Intermediate (WTI) decreased by 300% in one day, and it was getting traded at a price close to minus $40. This is a very unusual phenomenon, but it does occur in major crises such as the global recession of 2020, which took off forcefully. Listed herein are some points and explanations thereof about the US oil market collapses.
• The negative price of a barrel of oil is the price of trading on the stock market; it is the price of oil futures contracts for May that are sold and bought by financial investors. However, this does not mean that in the actual fields in the US there is no negative price.
• When the trading price was $20 in the contracts market, actual deals were being done at an average of $10 a barrel; today, the price is approximately minus $40, but there are contracts at $35 a barrel and others at actually minus $2.
• Some US shale oil producers have reached the point of paying their customers in exchange for taking production off their hands, particularly in fields and companies far from the coasts and storage locations, where the cost of storing oil has become high, and such companies need to dispose of it at any cost.
• The sub-zero price is indicative of the level of deep decline and stagnation in the global economy; oil continues to be pumped, while no one is demanding the accumulating oil.
• Global demand for oil has fallen by 30%, and particularly in the US, demand has declined while production quantities have not been reduced. Reducing quantities and stopping pumps and wells may lead to higher costs for restarting and greater losses in the costs of large idle equipment, which may make halting the flow of oil difficult, even as demand continues to decline.
• On the other hand, US strategic reserve storage is full, and the remaining capacity will be covered in under 7 days with the 70 million barrels per day US production.
• The losses are great in the US oil market, particularly for shale oil producers, which constitutes 63% of US oil production, and needs a price between $40-50 a barrel to cover its costs.
• These losses may lead to widespread bankruptcies in shale oil companies, but they may in turn lead to profits for the largest companies in the US energy and financial sectors, as they will lead to the restructuring of the sector – i.e. buying out the sector at the moment of the crash, which may be done through the government rescue package.
• All possibilities are open for the shale oil sector, but its production in the medium term is likely to shrink, as investments in the sector have declined by 20%, and its continued expansion, which has been ongoing since 2014, will stop, which might threaten the US position as the largest global producer.
• However, shale oil production may become more concentrated and relatively less expensive after the cost of investment therein has decreased, and it may go back to expansion later, but this depends on the size of losses in US production, the volume of subsequent demand for oil, and the course of the global economic crisis in the medium term.
• The US oil market has an important financial weight, as financial investment is broad in this sector, where 30% of the daily trading on the US commodity exchange takes place in the energy sector, and this may carry major financial losses, but it will push these funds to temporarily flee towards the dollar, which rises with every collapse in the market for stocks or commodities.
• This collapse cannot be limited to the US only, but will extend to affect the global oil price, Brent, the prices of the contracts of which are determined in London, as well as by the oil market financial investors, but the collapse of this price will harm other global producers.
• The dollar temporarily benefits from global oil collapses, and politically the low oil price puts pressure on US allies in the Gulf and on its enemies in Russia, and opens a door for battle and negotiations.
• However, collapses of this magnitude are a dangerous game for the global financial sector and the dollar, because the collapse of oil in the US market may have a domino effect in light of a volatile market and a global recession, which would transfer the impact from the US market to the Brent market, to collapse in the global stocks of energy companies and others, to the faltering debts of these companies and challenges to banks and the global debt system, as the debt of the global oil sector exceeded $2.5 trillion in 2014, and today it is much higher.
• Finally, the collapse of the global price through the financial markets in the US and UK may also push forward other pricing mechanisms, as in the Shanghai market, where oil contracts that China buys are priced in yuan, which is pegged by gold.
• The massive collapses in the oil market, the transfer of its effects to the financial market, and the opening of doors to other pricing mechanisms and currencies, seriously shake the dollar-oil relationship, and consequently the dollar’s position as a global currency, as the dollar’s global position is linked to connecting it to oil since the 1970s through the petrodollar system, which is experiencing major storms in the current collapse.